Investigating the Relationship Between the Financial and Real Economy
Investigating the relationship between the financial and real economy
Konstantinos Tsatsaronis
Central banks have always recognised the importance of financial stability for overall macroeconomic performance, but questions related to the health of the financial system have traditionally taken a back seat to those more directly linked to the process of inflation and growth. In recent years, however, financial stability has gained greater prominence on central bankers’ agenda. Monitoring the performance of the financial sector and the interaction between the health of financial institutions and macroeconomic stability has increasingly preoccupied central bank economists and decision-makers. The signs of intensified interest in financial stability are many. Central bank financial stability departments are explicitly mandated to monitor the performance of the financial sector and assess vulnerabilities. An increasing number of regular central bank publications devoted to communicating these assessments now feature prominently alongside other periodic publications more traditionally focused on macroeconomic developments. While these trends are especially pronounced among central banks that do not have direct supervisory responsibilities for financial institutions, they are certainly not confined to them. The reasons behind this more intense focus on financial stability are linked to the factors that have increased the vulnerability of the macroeconomy to financial system stress. There are both structural and secular factors at work here. On the structural side, deregulation has transformed the financial system, enabling financial firms to explore profitable opportunities more fully and to expand the scope of their activities. Intensified competition has promoted efficiency and encouraged innovation. As a result, the financial sector has grown rapidly both in size and in terms of its contribution to overall economic activity. At the same time, a deregulated
Konstantinos Tsatsaronis
Central banks have always recognised the importance of financial stability for overall macroeconomic performance, but questions related to the health of the financial system have traditionally taken a back seat to those more directly linked to the process of inflation and growth. In recent years, however, financial stability has gained greater prominence on central bankers’ agenda. Monitoring the performance of the financial sector and the interaction between the health of financial institutions and macroeconomic stability has increasingly preoccupied central bank economists and decision-makers. The signs of intensified interest in financial stability are many. Central bank financial stability departments are explicitly mandated to monitor the performance of the financial sector and assess vulnerabilities. An increasing number of regular central bank publications devoted to communicating these assessments now feature prominently alongside other periodic publications more traditionally focused on macroeconomic developments. While these trends are especially pronounced among central banks that do not have direct supervisory responsibilities for financial institutions, they are certainly not confined to them. The reasons behind this more intense focus on financial stability are linked to the factors that have increased the vulnerability of the macroeconomy to financial system stress. There are both structural and secular factors at work here. On the structural side, deregulation has transformed the financial system, enabling financial firms to explore profitable opportunities more fully and to expand the scope of their activities. Intensified competition has promoted efficiency and encouraged innovation. As a result, the financial sector has grown rapidly both in size and in terms of its contribution to overall economic activity. At the same time, a deregulated